The early bird catches the worm. Perhaps you’ve used this idiom in the classroom as a gentle reminder that being early (or at least on time) leads to success.
Now it’s time to follow your own advice and build your retirement savings sooner rather than later.
Here’s what you have to gain:
- Tax savings now through pre-tax contributions from your paycheck.
- Tax-deferred growth.*
- The power of long-term compounding interest.
What is compounding interest?
Compounding interest occurs when the money in your account earns interest, which then increases the balance in the account. The accumulated interest is reinvested and may earn even more interest. For example, say you have $1,000 that earns 5% interest over a year, or $50. At the end of the year, you'll have $1,050. The next year, you earn another 5%, only this time you've earned $52.50 ($1,050 x 5%), for a total of $1,102.50. The following year you earn 5% on the $1,102.50, and so on.
Why should I start saving early?
The benefits of tax-deferred growth and compounding interest multiply over time. Getting a late start means you may have to contribute more to achieve the same end result. For example, suppose you want to be a millionaire. If you started saving $300 a month at age 22 and earned an average annual return of 7%, you'd be a millionaire at age 66. But if you waited until age 32 and earned the same rate of return, you'd have to save $650 a month to reach the same goal.**
However, better late than never. Wherever you are on your career path, beginning to save or increasing contributions can help you get that much closer to your retirement goals.
* Taxes will be due upon withdrawal. Distributions before age 59 ½ (age 55 upon separation from service) may incur a 10% tax penalty.
** Rate of return is for illustration only and is not meant to represent the return of any particular investment.
With long-term, tax-deferred compounding, the value of reinvested earnings can become greater than the contributions you put in. For example, the chart shows the result if you invest $200 a month in a tax-deferred retirement account that earns a 6% annual return.* After 10 years of investing, the earnings in your account are about one-quarter of the total balance. However, after 30 years at the same rate of return, the earnings make up nearly two-thirds of the total balance.
* Return shown is for illustration only and does not represent the return of any actual investment. Your results will vary. Taxes will be due upon withdrawal. Distributions before age 591⁄2 (age 55 upon separation from service) may incur a 10% tax penalty (does not apply to 457 plans).